Legal · Board of directors

Should startup pay fees to Company Directors?

Brian Reale CEO / Founder ProcessMaker

November 26th, 2015

I am advising a startup that has 3 partners. All of the partners are directors of the company and have significant shares (more than 20%).  Only one of the partners is active in the company and draws a salary.  The other directors/partners are now requesting to be paid $50k per year as a director fee for serving on the board and attending 4 meetings annually.  The company does less than $5 million in revenue.  

I'd like to know how other startup companies pay their board of directors when the  directors already have a large % of the company but do not draw a salary.

Bruce Carpenter Co-founder and Principal, Harbour Bridge Ventures

December 5th, 2015

Harbour Bridge Ventures has served in an advisory capacity to a number of startups and early stage companies. Additionally, I personally serve on the both Boards of Directors and Advisory Boards of a number of privately held companies and have been an early investor also in several of those companies. Each of those situations varies in terms of the nature of the compensation arrangements involved. However, the common element in all of those is that the compensation has been based on real value provided and the amount of effort and time contributed to each situation. In cases where I have been an investor, my compensation has normally been in the form of the equity owned as a result of my investment. My involvement as a Director or Advisory Board member in those situations is directly tied to my wishing to closely watch over and increase the value of my investment. In many cases, my participation as a Director is a condition of my investment. Where my firm is serving in a professional advisory capacity to the company, we normally charge a monthly fee for our services either on a retainer or hourly basis and may also take a small, generally less than 5% equity stake which is granted only after certain milestones are achieved to which we have made a direct contribution.

In answer to your specific question and the particular situation you refer to, it seems to me that the equity stake granted to the directors not serving in active roles in the company other than participation in four meetings annually is already overly generous. In making this comment, I assume they have not made a financial investment or contribution to the company since you did not mention any investment made by them for their equity stake. Had we been advising the founders on equity allocation, we would have never suggested a stake greater than single digit percentages and often not more than 2% or 3% at most simply for serving as directors. In fact, we would like to see the directors in early stage companies taking a much more active role in promoting the company's success than simply attending several meetings per year. We like to see directors who can provide industry expertise and a network of contacts they will use in productive fashions to help the company succeed.

I see no reason in this situation to be paying additional compensation to the directors beyond their equity stake. In fact, I would likely be seeking to consider recapitalizing the company and in the process diluting the stakes of the current directors and reconstituting the Board. Not likely a popular suggestion with the current directors. However, it sounds like the initial equity allocation was not carefully thought through.

Michael Brill Technology startup exec focused on AI-driven products

November 26th, 2015

While most venture investors won't take cash compensation, there are definitely scenarios where it would make sense to pay them $50K. And, of course, they have the right to set their own compensation (assuming of course they don't violate their fiduciary responsibility to the company).

But since they, as majority equity holders, are accreting value from their decisions as directors, you could make an argument that they are double-dipping if they get additional compensation.

If that fails to dissuade them, then if the other two directors argue that $50K is fair annual compensation despite their equity positions, then I'd extend their principle to the third director (let's assume she's the President). Therefore the President's cash compensation and equity package should be bumped to fair market. That is, whatever the comp+bonus+equity package would be for a new outside President hire, should be given to this third director. The fact that she holds > 20% equity isn't material according to the other two directors' compensation principle.

So let's say that's another 8% over four years and another $100K annually. Now the two directors are looking at pulling $200K plus ~ 2% annual dilution from the company. 

Maybe that pushes the impact of their demands beyond what is reasonable for the company and they back down. 

Compensation is always a tricky subject. Good luck!

Roger Royse Royse Law Firm

November 26th, 2015

Very subjective question. Since they own so much stock, my guess is that they will serve even without cash compensation, to look after their interests.  It would be different if they were not stockholders and you needed their input on the board. Are they worth $50k for 4 meetings a year? Is this a disguised dividend? As you probably know, a dividend payment is not deductible to the corporation so it is in effect taxed twice (once when earned by the corp and again when earned by the shareholders). Service fees are deductible to the corporation, so they are in effect taxed only once. When you have fees of any kind paid pro rata to shareholdings, you run the risk of the IRS re-characterizing the fee as a dividend. Be careful out there

Liza Taylor Communication Specialist at Keyideas Infotech

December 5th, 2015

In my opinion Brian Reale , salary shouldn't be paid to directors who already own a good percentage of shares. If these directors are active and busy with their meetings, the company can think about their salary because they would be travelling frequently despite the cost of travel being sponsored by the company itself. Since you mention that one of the directors is active; he deserves a salary to be paid. 

Good Luck Brian. 

Brian Reale CEO / Founder ProcessMaker

December 5th, 2015

Thanks for all the input!  Very helpful.